DISRUPT

power and utilities

 on...

DISRUPTION
in the power and
utilities sector

Deloitte on... Disruption in the power and utilities sector 3

 Hindsight is 20/20
Take our electricityplease.

Paying customers to use your product is hardly a sustainable

business model. Yet thats precisely what happened in Germany
on June 16, 2013. When renewable energy generation soared to
61 percent of electricity output, the wholesale price plummeted to
minus 100 per megawatt hour (MWh). The supply of energy so
exceeded demand thatyesutilities were paying others to take
their electricity.

The repercussions? Significant value erosion, write-offs, investor

backlash, and intense pressure on executives to make tough
strategic choices about the future. It also signaled an about-
face in the utility sector with the German market becoming
increasinglyand irreversiblydominated by renewables. In July
2015, 78 percent of the nations power was generated from
renewable resources.

4 Deloitte on... Disruption in the power and utilities sector Deloitte on... Disruption in the power and utilities sector 5
Hindsight is 20/20
In hindsight, the shift that occurred on June 16 may have been
unprecedented. But it wasnt that surprising. And it didnt happen
without warning or provocation. In fact, the conditions for this
industry upheaval were years in the making.
A cacophony of forces fueled the disruptive
nature of renewables
In the decade leading up to that fateful day, German utilities bet
heavily on fossil fuels and nuclear energy, with the expectation
that energy consumption would continue to rise. Meanwhile, the
German government introduced feed-in tariffs to accelerate the
investment in wind power, biomass, hydropower, geothermal
power and solar, and other new energy technologies.
But energy demand didnt grow as projected, even before the
financial crisis. High energy costsin addition to government
subsidiespushed both industrial and retail consumers toward
self-generation. The growth in renewables as a result of additional
subsidies, along with the decline in energy demand, began to
challenge utilities after 2008. And widespread protests against
nuclear energy and the Fukushima disaster prompted the German
government to accelerate already-planned closures of its nuclear
power plants.
6 Deloitte on... Disruption in the power and utilities sector
Hindsight is 20/20
At the same time, the shale gas revolution lowered US gas prices,
reduced US coal imports from Europe, and drove down the cost
of coal in Germany. As utilities struggled to deal with events that
invalidated their fundamental assumptions of doing business,
renewables flourished. June 16, 2013, brought these long-term
trends forth with surprising force.
The utilities business model in Germany was
changed not by a single event, but by a series
of events that generated irreparable disruption
No matter where you sit in the value chain, the message is clear.
The lesson isnt simply about the importance of demand and new
fuel sources or about regulatory or societal pressures. Its about
envisioning different futures and considering the implications for
underlying assumptions in the strategy and the business model.
And responding accordingly when disruptions have the potential
to upend core beliefs and destroy value.
Deloitte on... Disruption in the power and utilities sector 7
 Scratch if. Think when,
how fast, and how big
Its unlikely that developments in the US utilities sector will mirror
what happened in Germany. But transformative forces are already
impacting current US power and utilities business models.

Some of those forces are trends, like slow growth in demand and
customers purchasing behavior; others are difficult-to-predict
uncertainties, such as the long-term balanced energy mix and
changing regulatory environment. As technology evolves, rules
change, and stakeholder expectations shift, its no longer a matter
of if the fundamental assumptions underlying the classic utility
business model will change or become obsolete. Instead, its
about when, how fast, and how big those changes will be.

8 Deloitte on... Disruption in the power and utilities sector Deloitte on... Disruption in the power and utilities sector 9
Scratch if. Think when, how fast, and how big

The pace at which this transformation will occur is uncertain, as

are the future roles of various players in the sector. Consider, for
example, that some customers have decided to generate their
own power, in essence becoming potential future competitors.
Technological development may challenge basic assumptions

Welcome
around grid infrastructure and the role of market participantsall
at a time when reliability, safety, affordability, profitability, and
environmental sustainability still remain critical value propositions
for power and utilities companies.

to the new
Customer demand is leading to rapid technology
advancements. To adapt, we will need to shift our
generation mix and operate our fleet differently so we
produce power and meet customer demand in cleaner,
more flexible wayschanging our business model to one
more tied to value than volume.
Stephen Parrish, Enterprise Risk
marketplace
Management, Duke Energy

The key lies in identifying, measuring, and monitoring signals

that may indicate what may come. Organizations that can
continuously recognize critical signals, separate those signals from
noise, and understand their impact will be better equipped to
adapt, survive, and thrive in the new order.

10 Deloitte on... Disruption in the power and utilities sector Deloitte on... Disruption in the power and utilities sector 11
 THE WORLD
TODAY
Generation
These trends are further driving
the world of tomorrow1
Transmission
and Technology is enabling consumer empowerment and
distribution forcing utilities to rethink their value proposition and
their brand
Up to the meter
Consumer preferences are being shaped by social,
economic, and technological changes, and brand
Behind the meter innovation is required to meet a host of consumer and
future workforce needs

Commercial
Customer re-prioritization is transforming the power
consumers and utilities value proposition, with a renewed focus on
Residential
total cost of electricity (e.g., environmental sustainability,
consumers
renewable integration) rather than just generation and
delivery cost
THE WORLD Increasing intervention from federal and state regulators
TOMORROW is transforming the market landscape
Continuous decrease in electricity demand and
reshaping of the generation portfolio (e.g., nuclear/coal
vs. gas/renewables) is changing market dynamics
Centralized Renewable
power and heat energy resources
generation

Smart transmission
and distribution The interaction of these trends is putting immense pressure
Smart energy
system center on the classic power and utility value proposition. Individually,
each trend can present new risks (e.g., operational, financial,
reputational/public trust) and also influence changes to
Pumped
existing risks. But when presented in combination, they have
hydro
the potential to create strategic riskswhich are risks to the
Electrification of transport
fundamental business model.
12 Deloitte on... Disruption in the power and utilities sector Deloitte on... Disruption in the power and utilities sector 13

Strategic risks attack the basis for competitive
advantage, challenge the logic of strategic
choices, threaten an organizations competitive
position, and can undermine a companys ability
to achieve or maintain exceptional performance
14 Deloitte on... Disruption in the power and utilities sector
Strategic risks are
a priority
At the heart of the traditional approach to strategy lies an
important assumption that, by leveraging a set of powerful
analytic tools, executives can place informed bets on the future.
Conventional wisdom suggests that applying this approach to any
business can allow leaders to choose a clear strategic direction
and then execute on it relentlessly.
But this approach may no longer be valid, and organizations
may find themselves caught by surprise when their bets dont
play out as imagined. This can result from a number of missteps,
including underestimating or failing to identify emerging risks,
over-dependence on historical data, non-linear advances in
technologies and customers expectations, falling into patterns of
groupthink, heavy reliance on the status quo, or insufficient focus
on risk discussions.
Deloitte on... Disruption in the power and utilities sector 15
 Strategic risks are a priority Strategic risks are a priority

In some cases, the speed of new disruptions may simply outpace
risk management capacity.
We are enhancing our risk management capabilities
to transition to a more dynamic and strategic process
that would allow us to keep up with quickening pace
of new developments.
Amir Angha, Enterprise Risk Management,
Southern California Edison
To understand what these strategic risks
mean to you, ask yourself these questions:
What assumptions are you making
about the future of the sector? Which
assumptions are already being challenged?
How will you navigate if the industry looks
completely different tomorrow? Will you
be ready to compete in new ways and with
new players?
How can a 100-year-old company change
its business model, culture, and value
proposition?
How much time do you need to change
your organization? How much time do you
have?
How can you proactively monitor potential
shifts within your fundamental business
model assumptions?

16 Deloitte on... Disruption in the power and utilities sector Deloitte on... Disruption in the power and utilities sector 17
Case in point: Marrying ERM and strategic planning
In the wake of the financial crisis, utilities felt the pain of tightening
credit markets and an unexpected drop in consumption. For one
company, this was a wake-up call that greater focus was needed
on planning for significant and unexpected external events. The
result? What the company calls ERM 2.0a marriage between
enterprise risk management and corporate strategy to create a
Strategic Enterprise Risk Management program.
The companys ERM 2.0 efforts identify and act on strategic risks
and opportunities by constantly scanning the utilitys environment,
regularly reviewing other industries and geographies, and
persistently questioning the assumptions that underlie its current
strategic direction. Traditional strategic planning tools help
crystallize insights about the future. And scenario planning helps
bound the range of possibilities while also preventing against
groupthink.
Time spent with the board is focused on forces (such as technology
advancements, changing consumer preferences, increasing
competitive pressure, and federal and state regulations) that play
the greatest role in shaping the future for the company and the
industry. A deep dive into each of these broad risk areas is done
each year and supplemented with ongoing and regular updates.
But understanding the risks and opportunities is only half the
challenge. Insight into the companys capacity to respond to risks,
in both the near- and long-term, is also important. The creation of
actionable plans is critical as well. Together, these form the basis
of the organizations strategic direction and plan. Ultimately, the
utilitys strategic-oriented ERM program allows for both a risk-
informed strategy and a strategic view of the risk landscape.
Contributed by Sabrina Greinel, Senior Program Manager,
Enterprise Strategy and Risk at PNM Resources
18 Deloitte on... Disruption in the power and utilities sector
Strategic risks are a priority
There are two sides to uncertainty: opportunities and risks,
both of which should be incorporated into an organizations
strategy. Unfortunately, some strategy professionals concentrate
their efforts on opportunities, giving short shrift to risks. As a
consequence, they might underestimate how much risk actually
factors into the development of their strategies.
The good news: Organizations can effectively manage uncertainty by
incorporating and enhancing strategic risk initiatives within their risk
identification, prioritization, management, and monitoring practices.
Incorporating an active strategic risk management perspective within
the risk function allows organizations to recognize imminent risks. It
also enhances the organizations risk culture and introduces a new
paradigm where risks, when spotted early and handled well, can
form the basis for game-changing moves that reorder the field and
create advantage.
Our CEO and the board are completely engaged in
the risk management process, challenging us to not
only get embedded in the decision-making process but
also to ensure that NYPA is able to clearly articulate
its risk-reward tradeoffs of the strategic decisions,
including those to address disruptive technology risk.
Soubhagya Parija, Chief Risk Officer,
New York Power Authority
Deloitte on... Disruption in the power and utilities sector 19
Strategic risks are a priority
The inclusion of risk during strategy development, rather than
as a means to validate strategy after the fact, can help leaders
face industry shifts head on and gain the confidence to navigate
challenges.
Preparing for multiple outcomes will mean the
difference between being the disruptor and
being disrupted
While it might be difficult to predict exactly how uncertainties will
evolve in the future, it is certain that the current utility business
model must evolve in order to remain relevant. This evolution
will require a major cultural shift, along with technological and
business changes. By no means will it be easy or familiar. But such
a transformation is possible.
Case in point: Preparing for uncertainty takes practice
For most of its existence, the US Army has engaged in
conventional warfare against nation states. But threats have
increasingly come from distributed, non-state actors with access
to dangerous weapons and unconventional ideologies. To adapt,
the Army moved from a centralized command and control
structure to a command and intent model.
This new model allows troops on the ground to better manage
uncertainty by granting them more autonomy and decision-
making authority based on intent shared by senior commanders.
20 Deloitte on... Disruption in the power and utilities sector
To help troops and commanders practice their decision-making
skills, the Army has ramped up efforts to include analytics and
gamification in its training.
While there are multiple agencies involved in intelligence
gathering and analyses, the Army often cant afford to wait for
perfect intelligence to reach the battlefield. Well-honed decision-
making skills can help troops and commanders make the most of
available information, perform rapid adjustments as needed, and
respond more effectively to challenges and conflicts.
This transition illustrates the Armys recognition that the nature
of warfare has undergone a fundamental evolution. It also
underscores the Armys understanding that, as wars are fought
differently, military doctrine must adapt accordingly.
Just as the Army is adapting to an evolving battlefield, power
and utility companies can gain advantage (or insight) by adopting
non-linear techniques to scan, discover, evaluate, and prepare
for alternative futures. It might be difficult or near impossible to
predict the future. But asking such basic questions as Are we
questioning our strategy enough?, What will make our business
model obsolete?, and Which of our fundamental business
model assumptions may be or is already being challenged? can
be a good first step.
Deloitte on... Disruption in the power and utilities sector 21
Giving outside opinions a
seat at the table
The ability to recognize the need for change is as crucial as the
ability to embrace and implement it. For several years, utilities
have followed the same business model of centralized power
generation, transmission, and distribution. They have operated in
an environment where energy use has only increased. And their
interests have been safeguarded by a friendly policy and regulatory
regime, supported by an investment community, provided market
protection, and benefited from seemingly mature technology.

A new environment is taking shape, however, and power and

utilities companies should reevaluate their business plans, question
their fundamental reason for existing, and explore new alternatives
and business practices. Some are already doing just that.

Deloitte on... Disruption in the power and utilities sector 23

Giving outside opinions a seat at the table

Our industry is being impacted by unprecedented

technological advancements and new competitors. I
can't conceive of anything more dangerous than for
us to think we are protected from competition; to do
so will be at our peril. Our success lies in a new era,
not in the past.
Ted Craver, CEO, Edison International2
What smart companies
Industry disruption is driving a new perspective
on the need to address strategic risks will do
A critical factor in effectively embracing change is the inclusion The challenge for power and utilities executives is to find new
of outside perspectives that challenge long-held beliefs. This ways to adapt to rapidly changing conditions, quickly identify
process can be liberating and exciting for some and extremely potential threats to their business models and strategy, and
uncomfortable for others. spot opportunities as they arise. Fortunately, the tools to help
As the industry transitions from regions of self-sufficient companies survive in a changing world do exist, and risk functions
monopolies to (in all likelihood) an ecosystem, the monoliths within organizations are well-positioned to support this challenge.
of the sector must overcome aversion to loss if they are to reap
future gains. Its still unclear which strategies will succeed. But all Smart organizations should develop a system to deal with
options must be considered and evaluated for potential risks and unexpected changes that threaten their business models and the
opportunities. fundamental assumptions behind their strategic initiatives.

24 Deloitte on... Disruption in the power and utilities sector Deloitte on... Disruption in the power and utilities sector 25
What smart companies will do What smart companies will do

This system includes people, processes, and capabilities to:

Discover. Scan. Confront. Prepare. Do it
Accelerate discovery. Todays power and with the best knowledge you can findabout
utilities companies must create regular, the world, your organization, and your team.
systematic mechanisms to accelerate the Great companies recognize that its the events
pace at which they discover sources of they can rarely predict that will reshape their
surprise. businesses. Standing still is not an option.
Scan ruthlessly. Potential sources of
change dont come with a big sign that says
historical market shift. Performing trend
analysis and future scanning can reveal
small, subtle indicators of change across a
range of industries and domains that could,
over time, produce a tipping point.
Confront biases. That will never happen
is the most dangerous phrase in todays
C-suite. No matter how experienced, no
leader or institution is immune to biases.
Once you admit to those biases, you can
begin to step outside yourself to observe
them.
Prepare for surprise. When an emergent
risk turns into a strategic threat, its too late
to study the problem. You must respond
with confidence, clarity, and precision.

26 Deloitte on... Disruption in the power and utilities sector Deloitte on... Disruption in the power and utilities sector 27
Interested? Plug into the conversation

In person
DMITRIY BOROVIK ANDREW BLAU
Director | Deloitte Advisory Managing Director | Deloitte Advisory
Strategic Risk Solutions Strategic Risk Solutions
Energy & Resources Leader Deloitte & Touche LLP
Deloitte & Touche LLP +1 415 932 5416
+1 212 436 4109 ablau@deloitte.com
dborovik@deloitte.com

Online
#strategicrisk, #disruption
www.deloitte.com/us/strategicrisk

Endnotes
1
Gov2020. A journey into the future of government, Deloitte University Press, 2015. As used in this document, Deloitte Advisory means Deloitte & Touche LLP, which provides
http://government-2020.dupress.com/ audit and enterprise risk services; Deloitte Financial Advisory Services LLP, which provides
forensic, dispute, and other consulting services, and its affiliate, Deloitte Transactions and
2
Edison CEO Ted Craver Says Innovation Key to Growth, January 2016,
http://insideedison.com/stories/edison-ceo-ted-craver-says-innovation-key-to-growth Business Analytics LLP, which provides a wide range of advisory and analytics services. Deloitte
Transactions and Business Analytics LLP is not a certified public accounting firm. These entities
are separate subsidiaries of Deloitte LLP. Please see www.deloitte.com/ us/about for a detailed
description of the legal structure of Deloitte LLP and its subsidiaries. Certain services may not
be available to attest clients under the rules and regulations of public accounting.

Special thanks for the contributions of Stephen Parrish, Enterprise Risk
Management, Duke Energy; Ted Craver, CEO, Edison International; Amir
Angha, Enterprise Risk Management, Southern California Edison; Sabrina
Greinel, Senior Program Manager, Enterprise Strategy and Risk at PNM
Resources; and Soubhagya Parija, Chief Risk Officer, New York Power
This document contains general information only and Deloitte Advisory is not, by means of
this document, rendering accounting, business, financial, investment, legal, tax, or other
professional advice or services. This document is not a substitute for such professional advice
or services, nor should it be used as a basis for any decision or action that may affect your
business. Before making any decision or taking any action that may affect your business, you
should consult a qualified professional advisor.

Authority. And to the editorial team: Asma Qureshi, Charan Puneet Singh, Deloitte Advisory shall not be responsible for any loss sustained by any person who relies on
Samra Lakew, and Will Dehnert, Deloitte & Touche LLP. this document.

Copyright 2016. Deloitte Development LLC. All rights reserved.

Member of Deloitte Touche Tohmatsu Limited.

28 Deloitte on... Disruption in the power and utilities sector